CO-MOVEMENT OF INFLATION AND EXCHANGE RATE: AN EMPIRICAL STUDY OF INDIA

This paper models a long run relationship between inflation and exchange rate. The study is motivated by the desire to ensure stability in exchange regime through a structurally nexus of inflation volatility and targeting. The paper established a significant long run positive relationship between inflation and exchange rate. An ordinary least square (OLS) regression, cointegration and Granger causality test were used to understand the relationship between inflation and exchange rate. The empirical results reveal that there is a unidirectional causality from inflation to exchange rate and the same result is indicated by the OLS regression. Based on the results of the research, appropriate policies can then be drawn giving insight to how exchange rate can perform its role without necessarily leading to inflation.